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January 22, 2013

CBS Hears the Call of the REIT: It’s Not the Taxes, It’s the Yield

NAREIT spokesman says there’s a big demand for high income in a low-yield market, but very few who can meet that need

CBS turned heads last week when it announced that it would spin off the outdoor advertising segment of business as a REIT.

The announcement last week gave shares of the entertainment company a 10% lift, its biggest rise in 17 months according to Bloomberg, and share prices this week are higher still.

Press coverage of the spin off has made much of the fact that REITs pay no corporate income taxes on income passed on as income to shareholders, as if the spinoff decision was a tax-savvy move.

But in an interview with AdvisorOne, Ron Kuykendall, vice president for communications of the National Association of Real Estate Investment Trusts (NAREIT), says the real story is not taxes but the ongoing search for yield in a low-rate environment.

“There is a global search for yield going on,” Kuykendall says. “Monetary policy is a key driver in this. It’s not a tax issue; it’s a monetary policy issue. The Federal Reserve has made clear it’s going to keep rates quite low for some time. And central banks around the world have said the same thing. Individual investors and sovereign wealth funds alike are looking for yield.”

It is this surfeit of income opportunities that are driving companies that are able to meet this investor demand.

“The economy is growing slowly, so companies are having a hard time delivering growth,” Kukendall says. “So income stocks are highly valued.”

But the NAREIT spokesman says there is no room for chicanery here; rather, companies must meet a test set by the IRS as to whether it is a REIT. “REIT rules require the company to truly be in the real estate business,” he says.

The IRS, which regulates REITs, defines a real estate company as one that as at least 75% of its assets in real estate and at least 75% of its income as coming from rents. Moreover, to avoid corporate tax, a REIT must pay out at least 90% its income to shareholders, though practically speaking, most pay out 100% of income as dividends to shareholders.

“That makes them very effective income stocks,” Kuykendall says.

But the CBS move is a not a tax story because from the company’s standpoint, there is no tax savings as such.

“They’re going to spin that off as a totally REIT-structured company,” he says. “REITs cannot retain earnings; that’s the flip side of not paying corporate tax.”

And don’t expect a whole slew of companies to convert to REIT status, despite the attractiveness of high dividends to investors, Kuykendall says. IRS rules ensure that only few will qualify. “There aren’t a tremendous load of companies which are available for conversions.”

Kuykendall says just one company—American Tower—converted to a REIT structure in all of 2012. The company owns land on which it builds cell towers it then leases to telecom companies.

“It’s exactly like a shopping center that leases space to stores like Nordstroms.”

And, he adds, there was little surprise in those companies, such as Corrections Corporation of America (CCA), that announced their interest in converting to a REIT structure last year.

“We had cell tower companies in [NAREIT’s] REIT index in the late ’90s; we had prison companies in the REIT index in the late ’90s,” Kuykendall says.